Micron Technology

Micron Technology reported eye-watering May-quarter results, beating revenue and earnings guidance by 24% and 31%, respectively. Revenue rose 346% year over year to $41 billion, non-GAAP gross margin rose to 85% (39% a year ago), and guidance implies further growth and margin expansion.

Why it matters: The artificial intelligence-driven memory pricing upswing is ballooning results. The key question for investors is when this cycle peaks and how far it falls thereafter. We continue to expect downward pricing pressure in 2028 from new capacity additions, but our peak expectations have risen materially. Bulls will argue that high prices are now structural, supported by parabolic demand for AI infrastructure and long-term supply agreements. For us, it's all about the supply/demand ratio (which we see narrowing in 2028), and we don't see these long-term agreements as ironclad for a downturn. We believe these new, stronger long-term agreements help hedge against the harshness of a downturn, but don't prevent it. We believe a small portion of total contracted revenue is truly guaranteed by customers in a downturn.

The bottom line: We raise our fair value estimate for no-moat Micron to $850 from $455, driven by significantly higher upcycle expectations. Shares rose 15% after hours on results, and remain overvalued to us. For long-term investors, we worry about a steep downcycle at the end of the decade. Our forecasts for the short-term upcycle, the cyclical peak, and the ensuing cyclical trough have all risen, driving up our valuation. We still expect a downturn in 2029, but believe prices will remain higher than pre-AI levels in the long term due to demand continuing to outpace supply. Our bearish call is not a call on AI demand, but simply an expectation that a glut of supply coming online in a short period will bring prices back down to earth. Memory chips trade like commodities, and even if demand remains high, an influx of supply should lower prices.

Micron expanded its horizon for the memory industry supply to remain tight, now calling for "beyond calendar 2027." This matches our view that prices will peak in 2028 before new supply brings them back down. Bulls could certainly dispute the steepness of the downturn we forecast for 2029 and 2030, and we believe the market is pricing in a future correction. Still, we don't believe Micron's lofty price today offers a compelling reward to long-term investors for the severe risk of a downturn they'd be buying into.

Management focused on its long-term agreements, of which 16 have now been signed, including "four very large customers," which we presume are a combination of hyperscale cloud players and potentially Apple. These contracts are structured as take-or-pay agreements, with price bands. Many of the smaller agreements are with automotive and consumer customers, which we expect to be relatively low-volume. The most binding piece we can concretely identify is cash deposits from customers as an indication of confidence, which Micron could hold onto in the event of non-payment. Still, these are a small portion of the total agreed-upon volumes—$22 billion so far, compared with more than $100 billion in "committed" revenue.

Baking this all into our forecast, we now expect Micron to reach $139 billion in revenue in fiscal 2026, implying a 20% beat on its August-quarter guidance, 270% growth, and $20 billion more than our prior model. In fiscal 2027, we expect revenue to more than double again to $340 billion, which is more than 50% higher than our prior model. Simply put, through fiscal 2027 (August end), we don't see meaningful new capacity coming online, and we expect prices to continue to rise as supply becomes more constrained, driving immense growth.

We forecast revenues to peak in mid-2028, followed by a steep two-year downcycle in 2029 and 2030. We now model Micron to settle at $150 billion in revenue in 2030, with more normal market conditions thereafter. This assumes five times the annual revenue of the firm's previous cyclical peak, driven by AI demand, creating a higher midcycle pricing environment. We believe the market is pricing in a softer downturn, maybe only a 30% correction from the peak (versus our expectations of closer to a 60% drawdown).

This all directly bakes into margins and earnings. We project gross margins to peak at 90% in fiscal 2027, and then compress to around 50% in 2030. This is, like revenue, significantly higher than prior cyclical peaks and reflects structural demand for AI. For earnings, we now expect a peak of $250 per share in fiscal 2028, about double our prior expectations, with most of the growth through 2028 to come as nearly pure profit for Micron. Our 2030 earnings estimate is just shy of $50 per share, which is well off peak but about 40 times higher than Micron's fiscal 2024 level.

Our fair value estimate for Micron is $850 per share. Our valuation implies a fiscal 2026 adjusted price/earnings multiple of 11 times and an enterprise value/sales multiple of 6 times. The greatest drivers to our valuation are DRAM demand and pricing growth over a large fixed cost base, with growth primarily driven by AI infrastructure investments.

We forecast Micron’s results to be cyclical in the long term and note that fiscal 2023 was among the most severe downturns we’ve seen for the chipmaker, with supply gluts across data centers, smartphones, and PCs following the postpandemic-era demand surge. Micron was also hampered in fiscal 2023 by the loss of revenue from memory sales to Chinese data center customers, due to retaliatory measures in response to other US government restrictions.

Through 2028, we see Micron benefiting from an unprecedented cyclical upswing. We see AI-driven demand for Micron’s HBM and DRAM chips as the firm’s largest growth driver, going forward. After more than 60% revenue growth in fiscal 2024 and nearly 50% growth in fiscal 2025, we expect AI to drive well above 200% growth in fiscal 2026. We expect another strong year of growth in fiscal 2027, with revenue more than doubling again. Thereafter, we model pricing to normalize, with growth slowing and peaking in 2028. In 2029 and 2030, we forecast a harsh downcycle, with revenue coming down more than 50% over two years.

While the DRAM and NAND markets can be volatile, we view long-term trends as showing growth in bit shipments (which equates to volume) and declines in price per bit. In DRAM, we expect high-teens bit growth and low double-digit annual pricing declines over the long term. In NAND, we expect mid-teens bit growth, and roughly 15% annual pricing declines over the long term. We see HBM boosting Micron’s DRAM bit growth and pricing, but for it to exhibit DRAM-like pricing declines after fiscal 2028 against robust shipment growth. Still, we observe HBM as margin-accretive, with roughly three to four times the price and only three times the cost as traditional DRAM on a per-bit basis in the long term.

Practically all of Micron’s costs of sales are fixed. Despite revenue cut in half in fiscal 2023, the cost of sales was roughly flat, leading to a negative 8% non-GAAP gross margin. We expect Micron to continue investing in manufacturing for the long term and gross margins to move in line with volumes. In the medium term, we see an impressive gross margin reaching 90% with high pricing across HBM, DRAM, and NAND. In the long term, we think Micron can maintain a gross margin level in the 40% to 50% range.

Micron’s operating expenses are more flexible than its manufacturing costs. We forecast steady growth in research and development in the mid-single digits over the long term, and for other operating expenses to track top-line volume. Still, Micron’s operating margins will be heavily dictated by its gross margins. In the current upcycle, we forecast non-GAAP operating margins rising to the high 80% range. At midcycle in the longer term, we think Micron can earn non-GAAP operating margins around 40%. This implies a significantly higher level than historical midcycle, with Micron durably benefiting from the immense scale up it’s experiencing in the current upcycle.

We do not believe Micron possesses an economic moat. The firm operates in the highly capital-intensive industries of DRAM and NAND flash semiconductors, and it doesn’t earn good enough profit margins through the course of a cycle to give us confidence in enduring economic profits.

We view DRAM and NAND as commoditylike products prone to market supply-and-demand dynamics and steady pricing erosion that reduces industry profitability. While we see better margins in DRAM, which has consolidated to three primary players (versus six in NAND) we still don’t see good enough returns on invested capital over the course of a cycle to merit a moat. We do expect to see years of positive economic profits during periods of tight supply and strong demand that help support good pricing, but we see steep downcycles giving rise to poor profitability and eroding the economic profits built up in a market upswing.

The majority of Micron’s sales comes from DRAM chip sales. DRAM chips provide volatile random access memory, which is used to store memory during a system’s operation, and only while a system is turned on. DRAM is a critical component for data center servers, computers, smartphones, and industrial applications. We see DRAM chips as commodity products, primarily sold by three suppliers—Samsung, SK Hynix, and Micron—that occupy over 90% of the market. DRAM technology generations last years, and we see the leading oligopoly players moving in step to successive generations and participating in an industry standards-setting body. DDR5 is the latest technology transition for mainstream DRAM, and while a player like Micron will cite technological leadership or being first to market, we view these chips as fungible and time-to-market differences of a quarter or two as immaterial to competitive positioning.

As a vertically integrated producer, Micron has massive capital investment needs that weigh on its returns on invested capital. The DRAM industry typically exhibits high-single-digit annual pricing declines, with the dominant players focusing not only on product advancement, but also advances in cost efficiency to keep up with their peers. This rapid pricing erosion makes it difficult for industry players to earn strong profits, even with large market shares. Consolidation of the DRAM industry and rational acting by players have helped improve industry margins. Still, we don’t see current margin levels providing durable economic profit levels over the course of a cycle. The memory chip market is prone to bouts of undersupply that raise prices and profits, followed by gluts of supply that crater pricing. Downcycles can be severe, sometimes leading to negative returns on invested capital and negative profit margins.

Micron also has a meaningful NAND flash chip business that makes up the minority of sales. NAND flash chips provide nonvolatile memory for storage purposes. Compared with DRAM, NAND is used for longer-term storage of data for data centers and consumer hardware. NAND advancements happen at a much faster pace than those in DRAM, with suppliers putting out higher-density chip generations every 18-24 months. Similar to DRAM, while suppliers will tout technological differences like layer counts and being first to market, we view NAND chips as fungible and commoditylike among the leading players.

We view very similar dynamics in NAND as we do in DRAM: commodity products, high capital intensity, and volatile market cycles. NAND, however, is less consolidated of a market with six primary players. In our view, the more fragmented nature of the NAND market creates more volatile supply-and-demand dynamics with worse pricing and profitability in market downturns caused by oversupply. NAND is also even more capital intensive than DRAM is, which we attribute to faster advancement and shorter product generations, and exhibits steeper annual pricing declines typically in the midteens. All of this leads to a lower margin profile for NAND compared with DRAM, as well as lower returns on invested capital.

When memory markets are in an upswing and demand is strong, Micron’s sales growth and profitability can be impressive.

Micron is benefiting from immense growth in HBM revenue, due to high investments in AI infrastructure. This boosts the firm’s growth and margin profile.

We like Micron’s shareholder returns and view its balance sheet as strong for a cyclical firm.

Micron has a high fixed cost base that leaves it vulnerable to underutilization charges and major profit compression when memory markets enter a downturn.

We see DRAM and NAND as commoditylike products, and we foresee little ability for Micron to build durable differentiation against its competitors.

Micron is extremely sensitive to memory pricing, and weaker pricing growth in an upcycle, or a more volatile downcycle in the future, can greatly depress its results and valuation.